Penalties are $10,000 to 50% of the account value per year and may include jail time.

Delinquent filings need to be handled carefully and consider all relevant facts.

History

The requirement to report offshore holdings began in 1970 with passage of the Bank Secrecy Act (BSA). The law was passed to combat money laundering and drug trafficking. By requiring banks to report transactions involving more than $10,000 in cash and other suspicious transactions, the U.S. hoped to make it difficult for criminal enterprises to move money.

Many people have financial accounts in foreign countries, but in the past few were admitting it or paying tax on the undeclared income, which funded the accounts. The Internal Revenue Service (“IRS”) is now actively pursuing un-disclosed accounts and evaded tax.

In an attempt to resolve the problem, Congress passed legislation requiring certain U.S. taxpayers to report their foreign accounts by filing a Form TD F 90-22.1 (later renumbered to Form 114) Report of Foreign Bank and Financial Accounts (FBAR) each year. In addition to mandating the filing of annual FBARs, the legislation forced taxpayers to retain detailed records about their foreign accounts. Form 114 must be filed electronically through the Financial Crimes Enforcement Network’s BSA e-filing system. U.S. persons who have a financial interest in or signature authority over ANY foreign financial accounts must disclose this on Schedule B, and if the aggregate value exceeds $10,000 at any time during the year, you must report ALL the accounts by June 30 of the following calendar year. Merely having a signature authority over an account can trigger an FBAR requirement. Often, clients have signature authority over accounts for elderly parents or as a function of their job requiring them to sign on company accounts.

Failure to comply with either of these requirements could lead to civil and criminal penalties. Despite these potential sanctions, FBAR compliance remained relatively low for years until Congress amended the law in late 2004 and added new penalties for non-willful FBAR violations and more stringent penalties for willful “blindness” violations. To implement this strengthened law, the U.S. Treasury Department delegated full investigatory and enforcement authority to the IRS. Now, the IRS has draconian civil and criminal penalties available to enforce FBAR compliance.

Enforcement activities have risen because of the Patriot Act. This over-reaching law cloaked as “anti-terrorism” to root out sources of funding for terrorist groups modified the relevant provisions to expressly state that the FBAR is vital to the U.S. government not only in carrying out criminal and tax investigations, but also in conducting intelligence activities to protect against international terrorism. Nowadays, once something is labeled as crucial to the far reaching “war on terror,” there are few limits on governmental efforts and enforcement powers. FBAR enforcement is on the rise. It is interesting to note that there has not been one instance of the Patriot Act being used to catch a Terrorist, but it certainly has been used to ensnare many Taxpayers.

What Constitutes a Foreign Financial Account?

Bank accounts are an example of foreign financial accounts, but other types of foreign investments and instruments also must be reported, including brokerage accounts, certificates of deposit, annuities, and Insurance policies with an investment component. This applies also to commodities accounts where investors can purchase physical metals or coins and leave it with the foreign investment company for safekeeping. The investment marketplace offers thousands of derivative investments. Tax advisers need to remember that the FBAR requirement involves much more than offshore bank accounts. In some countries, foreigners can’t own real estate but can own property through a trust whose interests may be reportable under the Foreign Account Tax Compliance Act (FATCA). The same is true for retirement-type accounts. (Treaties between the U.S. and the country where the account is held should be consulted when examining retirement vehicles.)

Tax Professionals

Tax advisers need to consider the many ways in which offshore reporting requirements could be triggered. They should always ask clients whether they have offshore interests and document the responses. In my firm we use a Tax Organizer and we discuss FATCA and the FBAR and include language in the Client Letter delivering the tax return to the Client that reminds the Client “If you have signature authority over foreign accounts and the aggregate value of all accounts was at any time over $10,000 during the tax year, you must complete and file Form 114.”

This article touches on FBARs, but many other offshore reporting requirements are in the Code, including the new Foreign Account Tax Compliance Act sections (§§1471–1474, which were passed as part of the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-147) (note that the definitions of qualifying foreign financial accounts are different), FATCA Form 8938 which must be filed with the Form 1040, Offshore gift reporting, Controlled Foreign Corporation, Foreign Partnerships, Foreign Trusts, and requirements of the Foreign Investment in Real Property Tax Act (FIRPTA), 25% or more Foreign Control of a U.S. entity report, and many more.

Every Tax Professional has a duty to educate themselves on how to at least ask about and recognize issues related to potential foreign activity requiring U.S. reporting. Any tax adviser who has clients with offshore businesses or interests and lacks the requisite experience should consider teaming with another practitioner or firm that has such experience, or with a knowledgeable tax attorney. The IRS has demonstrated a willingness to impose penalties against accountants who overlook foreign reporting requirements and expose their clients to risk and has reminded them of their duties under Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), when their clients have an FBAR filing duty. In several cases, the IRS Office of Professional Responsibility has even brought actions against Tax Preparers who negligently failed to file FBARs on behalf of clients.

The penalties for noncompliance can be devastating. In some instances, taxpayers may receive only a warning letter if the IRS determines the violation was mitigated by reasonable cause. A “non-willful” violation carries a civil penalty of up to $10,000 per year per account. If the IRS determines a violation was “willful”, the civil penalty can jump up to the greater of $100,000 or 50% of the highest account balance per year, per account.

Imagine inheriting $400,000 USD and not filing the FBAR for 3 years. The “willful neglect” non-criminal penalty could be $200,000 per year for 3 years and you might owe $600,000 USD to the IRS but you only had $400,000 to begin.

The IRS funnels Taxpayers into the “willful” penalty framework by requiring foreign accounts to be reported on Schedule B. This schedule is most often used to report Interest and Ordinary Dividends, and the Schedule B becomes part of Form 1040 U.S. Individual Income Tax Return.

Don’t forget Schedule B

In the excerpt above, there were no Dividends or Interest to create Schedule B, yet most tax software programs default to checking the boxes NO even though no Form Schedule B was ever generated. When the tax return is sent to the IRS, there is no “paper” tax return, rather it is transmitted electronically. The Taxpayer cannot inspect and sign a data string of 1’s & 0’s, all they can rely on is their Tax Professional’s expertise and their physical paper copy. Unbeknownst to the Taxpayer, the Schedule B is transmitted showing no Interest or Dividends AND the “default” NO answers indicated for the questions 7-8. Thereby giving the IRS “evidence” that the Taxpayer signed the Tax Return and indicated “NO” to the foreign account questions thus making the Taxpayer “willfully blind” and liable for the willfulness penalty.

The IRS believes such a failure is evidence of “willful blindness,” subjecting the taxpayer to the highest penalty classification (see Internal Revenue Manual §4.26.16.4.5.3(6) and Williams, 489 Fed. Appx. 655 (4th Cir. 2012)). Unfortunately, this often means unhappy clients and claims against the preparer.

How am I responsible if my Preparer doesn’t even know this stuff?

Generally, most everyone with income is required to file a tax return, most do so electronically by using software. This is where the break down occurs and the IRS “trap” springs shut. Generally, Schedule B is used to report Interest and Ordinary Dividends; but it is also used to report an interest in or signature authority over Foreign Accounts. Generally Schedule B is not required and can be omitted if the Interest earned or Ordinary Dividends earned is less than $1,500 (AND there are no foreign accounts). Since many taxpayers don’t have more than $1,500 in interest or dividend income, the software doesn’t generate the Schedule B, so the Taxpayer never even sees the questions lurking at the bottom of the schedule B and their accountant unaware of Foreign Reporting requirements fails to ask the questions related to those overlooked “insignificant” Schedule B questions on lines 7-8, thereby failing to check the appropriate box on Schedule B indicating the taxpayer has an interest in, or signature authority over, a foreign account.

The general public (and many tax preparers) think of wealthy American business owners with numbered secret Swiss accounts when the term “offshore account” is mentioned. In reality, millions of Americans were born outside the United States or legally work here through resident alien status. Add dual nationals and U.S. citizens living overseas, and the number of taxpayers and businesses with offshore accounts is enormous.

How is the IRS going to find my Foreign Financial Account?

Thinking of simply “laying low” and not being discovered? Consider carefully and read this news release. “January 17, 2013, the U.S. Treasury Department and the Internal Revenue Service (IRS) released the long-awaited final regulations for the Foreign Account Tax Compliance Act (FATCA). FATCA, codified as Chapter 4 of the Internal Revenue Code, represents the Treasury Department’s efforts to prevent U.S. taxpayers who hold financial assets in non-U.S. financial institutions (foreign financial institutions or FFIs) and other offshore vehicles from avoiding their U.S. tax obligations.

The intent behind the law is for foreign financial institutions (FFIs) to identify and report U.S. persons that hold assets abroad to the IRS, and for certain non-financial foreign entities (NFFEs) to identify their substantial U.S. owners. In order to comply with the rules, FFIs are required to enter into an FFI agreement with the U.S. Treasury or comply with intergovernmental agreements (IGAs) entered into by their local jurisdictions. U.S. withholding agents (USWAs) must document all of their relationships with foreign entities in order to assist with the enforcement of the rules. Failure to enter into an agreement or provide required documentation will result in the imposition of a 30% withholding tax on certain payments made to such customers and counter-parties. Failure to impose the requisite withholding under FATCA requirements could result in significant financial exposure.”

The Matrix below details the timeline the IRS and Foreign Government and Financial Institutions have set for implementation of automatic reporting.

What does all this mean?

It means the IRS and Foreign Governments have agreed to heavily penalize Foreign Financial Institutions who fail to report ALL their account holders with U.S. ties (not simply U.S. Citizens). This means the Intergovernmental Agreements (IGA) are tightly integrating Bank, Tax, Immigration, Customs & Foreign Tax Authorities. If you are travelling on a Foreign Passport to the U.S. or have a U.S. visa or are a Long Term Permanent Resident (Green Card) or U.S. passport and have travelled abroad, you can be certain that the IRS will be sharing your information with the countries to which you have travelled or have ties or activities.

This system is going to effectively result in something similar W-2 & 1099 reporting without giving the account holder the paper slip confirming that they have been reported. Travel to a Foreign Country, you can bet the IRS will send an Inquiry to see if you have accounts there. If you have an account and the bank has any reason to believe you might be a U.S. person (statement mailing address, passport, email, or account logon IP address, etc…) you should be certain you will be reported and the IRS will be checking to see if you have been reporting past years and present.

What incentive does a Foreign Institution to report account holders?

The U.S. wields a lot of economic power and denying Foreign Institutions access to U.S. markets and massive penalties are a big stick that has the Foreign Institutions getting in line. Also, any institutions that are not complying are quickly being found out because the account holders (U.S. taxpayers) are self-disclosing their accounts and thereby reporting the Banks who are in turn being penalized for not reporting the U.S. account holders.

What do I do now?

If you have already filed your Tax Return and you have foreign accounts or other foreign attributes such as a business with Foreign Partners, or you received a Gift or Inheritance, or you are a signer on a foreign account but have no financial interest in the account, you should at least have copies of the required disclosures that should have been made. If you had offshore accounts or other foreign activities but don’t have a Schedule B and Form 8938 or Form 114 or other documents in your “Client Copy” of your tax return, you are risking severe bankrupting monetary penalties and possible criminal penalties for failing to make timely disclosures.

I’ve not disclosed any of my Foreign Activities – Am I in Trouble?

The answer to this question is heavily dependent on the facts and circumstances. If you simply did not know and you failed to report and there was no income, you may be able to avoid penalties by making ALL the late disclosures AND include a carefully worded reasonable cause explanation that meets the IRS definition of “Reasonable Cause” (I strongly recommend you seek the assistance of a Professional experienced with FATCA penalty abatement). Good reasonable cause facts might include blaming your tax preparer, being new to the U.S., no unreported income was received or used to fund the offshore account, AND the IRS has not already discovered your un-disclosed accounts. If your Tax Advisor led you into this mess, they have a real conflict of interest and may not be the one best suited to lead you out considering their skin may be on the hook as well.

If your fact pattern is not so favorable, all is not lost and you are not necessarily “in trouble” but the time to act is now. “Stop the bleeding” and hire a professional to shepherd you through the mine field of traps, penalties for willful non-compliance, asset seizures and risking potential indictment for tax evasion and losing immigration status or deportation. The simplest analogy I can think of is driving over the speed limit. You have been driving over the speed limit for years and have not been caught, the best time to stop violating the law (and avoid penalties) is now, before you are caught. The worst possible defense once you are caught is to say “well I got away with it for years”.

Once the IRS inquiry arrives in your mailbox or worse, appears on your doorstep wearing dark suits with badges, you are likely in some peril; remember two important things.

Don’t engage in conversation at all for any reason, not even to be polite or to appear “innocent”. Do not let them in your home or business, do not answer any questions, do not give them anything and do not sign anything. Simply ask for their card and say your representative will contact them. End the conversation. (Every person convicted of a tax crime talked when they should’ve kept quiet)

This is fixable, but the fix is more difficult (and expensive) for clients who ignore step one above.

I’m still uncertain what all this means, where do I start?

This entire FATCA business is certainly confusing, lots of terms, requirements, deadlines, penalties and it may seem easiest to ignore it and hope it goes away. It won’t go away, but we can make it less troublesome. Much like filing your tax return, although a nuisance, but not something to worry about losing life savings or your freedom over. Call to discuss your situation with a Professional experienced in FATCA matters.

If you are a Tax preparer, CPA, EA, or Attorney, and need assistance with current filings, or your clients have never filed anything FATCA related for past years, contact us and we can assist you and your clients mitigate and or avoid penalties and worse.

Marc Enzi CFP®, EA is a Certified Financial Planner™, and an Enrolled Agent licensed by the Department of the Treasury to represent clients before the Internal Revenue Service, and a Certifying Acceptance Agent for the IRS. Marc represents the client’s best interests in Federal and State tax matters. Tax Solutions is a Globally Trusted Firm helping people in the U.S. and offshore Expatriates and Foreign Nationals with IRS matters. Our staff of licensed tax experts specialize in tax consulting, planning, preparation, and tax controversy.